NISM Series IIA: Chapter XIV — Secondary Market Transactions

Once securities have been successfully issued in the primary market, they can be bought and sold among investors in the secondary market. In this market, securities are purchased from other investors rather than directly from the issuing company. Consequently, the financial proceeds of these transactions flow directly to the selling investor, not to the issuer.

The secondary market is critical to the financial system because it performs several vital functions:

• Price Discovery: Investors buy and sell shares based on their estimation of the stock's value, taking into account all available information that might impact the company's performance. When a large number of investors evaluate a stock, their collective actions establish an appropriate market price.
• Information Dissemination: Accurate price discovery depends on the quality and timeliness of the information available to investors. An efficient secondary market establishes a structured channel for periodic, relevant, and timely information to reach the public.
• Liquidity: The secondary market provides a continuous mechanism for investors to exit their investments by matching them with buyers at mutually acceptable market prices.

1. Organized Stock Markets in India

The organized secondary market for securities is formally referred to as the stock market. In India, the principal stock exchanges facilitating these transactions are the National Stock Exchange (NSE) and The Stock Exchange, Mumbai (BSE).

Principal Features of Stock Exchanges

• Regulatory Oversight: Every recognized stock exchange is closely regulated by the apex capital markets regulator of the country (SEBI).
• Integrated Infrastructure: Stock exchanges provide a unified platform that handles the trading, clearing, and settlement of trades.
• Screen-Based Trading Platform: Major Indian stock exchanges facilitate electronic, screen-based trading from broker offices located nationwide. This trading system operates on two core principles:
  1. Anonymous Trading: The identities of the buyers and sellers are kept completely confidential during order matching.
  2. Price-Time Priority: Trades are automatically executed at the best available price at any given point in time (the lowest price if buying, and the highest price if selling), with older orders taking priority at a given price point.
• Order Flexibility: The electronic system allows investors to structure their trades based on specific parameters, such as the period of validity of the order and the precise manner in which the order should be filled.
• Membership Regulation: Stock exchanges enroll and supervise their participating members and institutions. Exchanges establish strict operational bye-laws defining criteria for membership, capital adequacy, and professional conduct.

2. Participants in the Stock Market

Multiple entities interact on the stock exchange platform to execute secondary market transactions, subject to clear eligibility and intermediary rules.

Investors

• Eligible Investor Categories: SEBI regulations permit a wide range of investors to trade in the Indian stock markets, including resident investors, Non-Resident Indians (NRIs), corporate bodies, trusts, and registered Foreign Institutional Investors (FIIs).
• Prohibited Entities: Overseas Corporate Bodies (OCBs) are strictly prohibited from investing in the Indian securities markets.
• Intermediary Requirement: Investors cannot trade directly on the stock exchange platform. They must route all transactions through SEBI-registered stockbrokers who hold membership with the exchange.
• Account Opening & KYC: To initiate trading, an investor must open a dedicated trading account with a broker and fully comply with Know Your Customer (KYC) documentation standards.

Key Intermediaries

A. Stockbrokers

• Definition & Role: Brokers are registered members of a stock exchange who are uniquely authorized to execute and put through trades on the exchange's trading platform.
• Entity Types: Brokers can be registered as either individuals or corporate institutions, provided they meet the eligibility and capital criteria set by both SEBI and the respective stock exchange.

B. Depository Participants (DPs)

• Definition & Role: DPs are registered associates of a depository (such as NSDL or CDSL) through whom investors open and maintain their electronic beneficial owner accounts.
• Settlement Duty: DPs are responsible for executing the investor's delivery and receipt instructions to transfer dematerialised shares out of or into their beneficiary accounts, thereby settling trades executed in the secondary market.

3. Listing of Securities

To allow its shares to be traded on a stock exchange, a company must formally list its securities. Stock exchanges impose strict eligibility and regulatory requirements before granting listing status to an issuer.

Listing Eligibility Requirements

1. Minimum Continuous Public Holding:

   • Standard Requirement: A listed company must maintain a minimum continuous public shareholding of at least 25 percent of the total number of issued shares for every class of listed security.

   • Large-Cap Relaxation: The minimum continuous public shareholding can be set at 10 percent for specific classes of shares if the company’s post-issue capital (calculated at the public offer price) exceeds Rs. 4,000 Crores.

   • Formula Representation in Simple Line Format: Minimum Public Shareholding = 25 percent (Standard) or 10 percent (If Post-Issue Capital at Offer Price > Rs. 4,000 Crores)

2. Pre-tax Operating Profits: The company must have achieved a minimum average pre-tax operating profit of Rs. 15 Crores.

3. Constitutional Documents Approval: The Memorandum of Association (MOA) and Articles of Association (AOA) of the company must be formally approved by the stock exchange and must contain all relevant provisions mandated by the Securities Contracts (Regulation) Act (SCRA).

4. The Listing Agreement: The company must execute a formal, legally binding Listing Agreement with the stock exchange, which explicitly defines the ongoing obligations of the company toward its investors.

4. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015

To protect public investors and standardize disclosures across listed companies, SEBI notified the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (popularly known as the LODR Regulations), which became effective on December 1, 2015. These regulations prescribe specific, tiered disclosure and compliance requirements tailored to different categories of listed securities.

Scope and Applicability

The LODR Regulations apply to all listed entities that have listed any designated securities on a recognized stock exchange.

Broad Compliance Features Covered under LODR

The regulations establish a comprehensive compliance blueprint covering:

• The applicability criteria of the regulations.
• Common ongoing obligations to be performed by all listed entities.
• Specific quarterly compliances, including strict timelines for submission.
• Corporate events requiring prior intimation to the stock exchanges.
• Significant corporate events requiring compulsory intimation within 24 hours of occurrence.
• The exact composition rules for the Board of Directors and its key committees.
• Regulations governing Related Party Transactions (RPTs).
• The mandatory agendas to be tabled at Board meetings.
• The agendas to be placed before Audit Committee meetings.
• The specific agendas and proposals to be placed at upcoming general meetings of shareholders.

Common Obligations and Executive Liability

The regulations place direct statutory responsibility on the key leadership of the company. A specific, legally binding responsibility is cast upon Key Managerial Personnel (KMPs), Directors, and Promoters ensuring that they strictly comply with all obligations and responsibilities assigned to them under the LODR framework.

Summary Reference Table: Secondary Market Structures and Listing Norms

Key Terms Glossary

• Secondary Market: The financial market where already issued securities are traded among investors, without involving the original issuer in the transaction proceeds.
• Price Discovery: The process by which the market determines the price of a security based on the interactions of numerous buyers and sellers evaluating public information.
• Anonymous Trading: A trading system feature where the identity of counter-parties remains completely hidden during order matching.
• Price-Time Priority: A rule ensuring that orders are executed based on the best price first, with older orders prioritised in cases of identical prices.
• Overseas Corporate Bodies (OCBs): Foreign corporate entities that are strictly prohibited from participating in the Indian securities markets.
• Listing Agreement: A contract between an issuing company and a stock exchange defining the continuous disclosure rules the firm must follow to remain listed.
• Key Managerial Personnel (KMPs): The key executive officers of a company (such as the CEO, CFO, and Company Secretary) who bear direct liability for LODR compliance.

Chapter Key Takeaways

1. Direct Investor-to-Investor Trades: In the secondary market, transactions occur between investors; the issuing company receives no cash proceeds from these trades.
2. Price-Time Priority Rule: Screen-based exchange trading systems in India operate on price-time priority, ensuring investors automatically get the best price available at execution.
3. Strict Ban on OCBs: While FIIs, NRIs, and residents can invest in stock exchanges, Overseas Corporate Bodies are completely barred from Indian securities markets.
4. Flexible Public Floating Rules: Standard listed firms must maintain a continuous public shareholding of 25%, but very large companies (>Rs. 4,000 Crores post-issue capital) can dilute this requirement to 10%.
5. Strict Corporate Governance Liability: The SEBI LODR Regulations of 2015 hold KMPs, Directors, and Promoters personally liable for ensuring continuous and quarterly disclosures, with certain critical events requiring exchange notification within 24 hours.